Sensible nonsense

September 2020

Key points

To stand the best chance of owning the winning companies of the 2030s, we should imagine how bizarre today’s ‘normal’ will seem when the next generation looks back.

All investment strategies have the potential for profit and loss, your or your clients’ capital may be at risk. Past performance is not a guide to future returns.

In ways few foresaw, the coronavirus tragedy accelerated many of the long-term secular trends already benefitting holdings in the LTGG portfolio. Existing company strengths boosted by the pandemic include Tesla’s lack of physical car dealerships (and lack of a need to visit petrol stations) and the ecommerce pioneers’ ability to continue serving customers exclusively online. Also favoured were companies who allowed us to take greater charge of our health at home – whether in the form of Dexcom’s continuous glucose monitoring devices or Peloton’s exercise machines. Thus the behavioural changes wrought by lockdown have helped some of these shifts achieve ‘escape velocity’.

And that’s before we consider the mass social experiment of working from home and how it has helped remove the moat and walls of impregnable corporate castles. Even forward-thinking software multinational Atlassian, whose pre-virus remote workforce represented its third largest ‘office’, now looks like the standard rather than the stand-out. To paraphrase the sci-fi author William Gibson, the future has already arrived and, for better or worse, it has been forcibly distributed.

So where do we go from here? If the future has already arrived, shouldn't we just sell out? If the holding period for the LTGG portfolio is around a decade, when do you decide to move on? And move on to where? Why are you taking so little apparent action? Heck, what do you folks do all day?

Here follows a possibly counterintuitive defence of inaction and why it matters. It explores how we might identify the next generation of companies we hope to own on our clients’ behalf in 2030. This involves asking what we’re doing today that may seem nonsensical when looked back on from that longer-term vantage point.

Inaction is hard to achieve amid short-term exuberance. Life bombards us with calls to action. As a race, humans value spontaneity. We are comfortable with impulsiveness, perhaps more so now than ever before: Instagram ads have elevated this instinct to a benign artform, benefitting niche brands aimed at the most receptive audience. For example consumers who never knew they wanted, say, a 3D map of Edinburgh crafted from sustainable wood (it seemed a good idea at the time).

Nowhere are prompts to do something more prevalent than in the investment industry with its torrent of ‘research’ and its unceasing exhortations to BUY! or SELL! When Jeff Bezos founded Amazon he argued that only one measure matters in the long run: the present value of future cashflows, anticipation of which means spending cash today. But it’s hard to stay focused on such distant hopes while a chorus of unsolicited opinion predicts, depending on mood, imminent demise or world domination. As long-term investors, we must resist the urge to trade on the chorus.

Inaction also requires humility. Conventional wisdom holds that the most destructive error an investor can make is to fail to sell on warning signs or when an opportunity has run dry. As a team we’ve certainly been guilty of slowness to react to insidious – not necessarily terminal – hints of cultural atrophy that are harder to spot than outright ‘red flags’.

This fallibility pales next to another natural urge that risks destroying vastly more value: the failure of imagination that causes us to sell too early, or to be too tentative in our initial commitment, because we fail fully to appreciate the possibilities. Research conducted by Professor Hendrik Bessembinder shows that special companies – the outliers we seek – are statistically rare but have a common quality that doesn’t appear in financial statements: adaptability.

Often the opportunity turns out to be larger than initially thought because in many instances these companies create it themselves. Mark Urquhart has banned talk of ‘total addressable market’ (TAM) for this reason.

Consider Zoom, a stock that piqued our interest because we thought seamless video conferencing might begin to erode working norms such as centralised offices and business travel. Recent months have seen an explosion in use as companies and individuals reached for a frictionless means of keeping in touch. Zoom reacted remarkably well to becoming a household name and the intense scrutiny that involves. We are encouraged by CEO Eric Yuan’s humility in seeking counsel from other founder-CEOs he admires and openness in addressing user concerns.

In our note on Zoom from January – presumptuously titled ‘An attempt to imagine the upside’ – we pencilled in a doubling of paid customers from around 73,000 at the time, perhaps over the coming five years. The figure most recently disclosed was 265,400. So, what does the remaining opportunity look like? How do we go about ‘imagining’ the upside?

According to the International Air Transport Association, global kilometres flown in commercial passenger aircraft in 2019 were about 8.3 trillion kilometres. How much of this was ‘on business’? That’s tricky to ascertain but if we take the crude measure of excluding low-cost airlines (a quarter of the total) and take a third of the result we arrive at a rough-and-ready guesstimate of 2 trillion kilometres. The ratio of business or first class to economy seats averages around 20 per cent but clearly not all business people fly up front and not all tourists fly economy. Your average airline cruises at 900km/hr so that gives us 2.2 billion hours spent by business travellers sitting in aeroplanes each year.

Let’s assume that for every hour a business traveller spends inside an aircraft, a further 45 minutes is wasted on the ground: crawling in traffic, suffering the ignominy of security screening, parked in the mediocre lounge with its patchy WiFi and limp sandwiches. Indeed, 45 minutes could be conservative when taking account of all the taxiing and holding that the actual aircraft has to do before getting airborne. And for all this, we’d guess that the ratio of ‘travelling to’ vs ‘being at’ the destination averages out at 4-to-1, and that in any case you’d rather be tucking your kids into bed.

That crude calculation gets us to an eye-catching one trillion minutes spent by the global business community each year in a poorly-pressurised and dispiritingly-catered aluminium tube in the name of ‘building relationships’ or ‘conducting business face-to-face’.

The ‘real life meeting’ is unlikely to disappear entirely of course, but it’s possible that it might become a rarity, not the routine. If so, and if Zoom saves even a quarter of those trillion minutes, and we value the saving at a modest $10 per hour, then the opportunity exceeds $40 billion, or 20 times Zoom’s current revenues. Such an outcome seems shocking but it’s not implausible if Zoom becomes a communications default.

Paying $1 million each year to Zoom might look moderate relative to an annual corporate travel bill that used to reach many, many times that figure. The size of that bill is only going in one direction as airlines charge ever more for fewer services and as carbon taxes skyrocket.

To be clear, these are extreme scenarios for which we must calculate probability rather than assign certainty. They do, however, stem from thinking about why certain companies drive so much change. Let’s call it ‘nonsensicality’. Taking the nonsensical approach involves asking what things we accept as fixed or immutable today that a child born in 2020 might come to question disbelievingly as a teenager. ‘Did we really do it like that? Why?’

Imagine for example introducing today’s teenager to the dial-up internet of the early noughties. Those of us of a certain age remember how connecting took an interminable 30 seconds and sounded like making contact with aliens in the Orion belt via a base station in Siberia. Then there were the arguments between those chatting to friends on MSN Messenger (the Snapchat of its era) and anyone needing the line for a phone call. It all seems nonsensical now.

This doesn’t mean you could have predicted the iPhone and TikTok while your teenager hogged the phoneline. The second-order effects of technology shifts unfold in surprising ways. It’s easy to forget that we’re very far from fully exploiting the shifts that began with dial-up. A recent example is a contention from our Unlisted Equities Team – that the current social media model will compete with other models such as Fortnite. According to the team’s note, Fortnite’s creator Epic Games “makes money when its customers choose to buy something of value, not when it has exploited a behavioural weakness or sold their private data”.

The nonsensicality model suggests where we might hunt for future holdings. In that spirit, here are some current norms that might make no sense at all by 2035:


Where we’re headed, we don’t need roads

Edinburgh and Glasgow are partly connected by the picturesque Union Canal. The waterway was conceived in 1817 to give the capital access to cheap west of Scotland coal. Canal companies were the hot stocks of their day. A 1792 meeting to promote a canal from Gloucester to Bristol “was enthusiastically supported by influential persons, and a very large sum subscribed for by those present, who violently struggled with each other in their rush to the subscription book.” The Union Canal, of course, met its end as necessary infrastructure thanks to a faster competitor that involved far less friction: the railway. An analogy today is the intense interest in all types of companies working to improve on the current paradigm by electrifying transport, a trend that seems as inevitable now as it was maligned a decade ago. Nothing demonstrates how much this was the case quite as well as, in 2010, the then-head of research and development at Volkswagen dismissing electric vehicles, saying that the battery energy density was “worse than chocolate” and predicting they would be less than 10 per cent of the vehicle fleet in 2028.

To be clear, the notion that electrification could come to the fore is far from speculative. A petrol engine converts not much more than 15 per cent of available energy to motion, while 85 per cent is emitted as heat and noise along with pollution. This will surely seem as quaint in 10 years’ time as dial-up internet does today.

On a longer timeframe though, aren’t we just building a better barge? Does the ultimate removal of friction in transport belong not to the roads, even with electric vehicles, but to the air? The embryonic eVTOL field – electric vertical take-off and landing aircraft – could radically reshape how we think about travel. The infrastructure requirement is vastly lower than roads. What happens if you could be picked up anywhere and fly anywhere at three times the speed of road transport, on demand, autonomously, for much less than a Lyft ride today? Might cars feel like houseboats do today? Could road travel as our primary means of getting places seem an anachronism?

Cloud infrastructure

The network is the computer

We recently took a holding in Cloudflare. The company runs a global network of data centres that are – in contrast to the big centralised data centres run by AWS or Facebook – ‘embedded’ in the fabric of the Internet. In plain English, Cloudflare’s equipment is dotted around the globe with internet service providers such as Verizon or Virgin Media, or their equivalents in China and India etc. This means that Cloudflare has computing power that is closer to wherever you or your employees or customers happen to be. Historically the company has used this capability to protect corporate websites against malicious attacks: it’s easier to stop attacks if you’re always near the source. More recently, Cloudflare has aided the transition to the new work-from-home world that many of us now inhabit. Rather than millions of workers being in an office and connecting to an IT resource locally, that same resource can be hosted on Cloudflare’s global network, and the company enables employees to access it securely and quickly, wherever they are.

The fascinating question is what might come next? In the current world of devices – your mobile or your laptop – you own the componentry inside, meaning the processor or the graphics chip and so on. We don’t even think about this. What if you remove this requirement though? What if your device was purely a terminal – a screen, say, or augmented reality device – that had access to vastly more powerful computing provided not by the device itself but by the network?

What might seem nonsensical when looked back on from such a world? Perhaps the concept of ‘installing’ apps and ‘saving’ work will seem silly: the programme you are using just streams to you like a Netflix show (Microsoft Azure already offers this, but not yet on mobile devices). And perhaps our 2035 teenager might marvel at how we all used to stare down at our phones and type with tiny letters on a tiny keyboard. She just wears a ‘neuroband’ that beams content into her field of vision and is controlled by signals detected through her wrists. This kind of neuro-interface technology already exists, pioneered by CTRL Labs, acquired by Facebook in 2019.


Ruminating, but not innovating

Prior to founding Impossible Foods, Pat Brown was a professor in biochemistry and genetics at Stanford University. He decided to tackle a hard problem during a sabbatical and came to the view that “animals as a food production technology” – and cows in particular – were the biggest challenge available for study. Arguably more than in any other aspect of human life, the raw numbers are genuinely nonsensical. Half of the surface area of Earth is given over to animal husbandry in one form or another. If you totalled every cow on earth and weighed them, they would sum to 10 times every other vertebrate on earth – humans included – combined!

As Professor Brown also points out, animal muscle did not evolve to provide human nourishment. There is nothing magical about the cow. At a biochemical level, it amounts to a series of properties, such as the ratio of various amino acids, and molecules (notably iron) that can be replicated using plants or safely engineered from genetically modified yeast. The mission of Impossible is therefore striking: eliminate the use of animals in human food production by 2035.

This sounds outlandish in the here and now, but the mindset shift required is not radical – and has already begun. Perhaps in 50 years’ time raising live animals for food will be viewed – as Yuval Noah Harari has suggested – akin to enslavement and a moral crime. In the meantime, would it not be enough for our 2035 teenager to feel repulsed by the notion of a cow patty? ‘Aren’t those full of antibiotics? No thanks, yuck…’

The point of these vignettes is not to point confidently towards the future, less still to predict the path of any trend with precision. Many companies involved in the above areas will fail, as has always been the case. Nor is being first on the scene a guarantee of success. Where the ‘nonsensicality’ framework can help us, is by opening us up to these possibilities by considering whether the endpoint makes sufficient sense – and by extension, by dispelling the illusion that the current state of technology or human progress is static.

‘OK, boomer’ has famously become Generation Z’s riposte to older generations who don’t ‘get’ the things that matter to them, or who are resistant to change. Pushing ourselves to spot companies that might produce the outlier returns of the next 10–15 years means asking ourselves what the next generation will laugh at us for not ‘getting’: the things that will seem natural in the future, and resistance to which will meet with “Ok, Zedder” from the generation that follows.

Risk Factor

The views expressed in this article are those of the autahors and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.

This communication was produced and approved in September 2020 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking.

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